How to Plan for a Key Loss in Your Small Business

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By Nathaniel Broughton, partner at Plus2 Capital.

It’s a somber thought, but what would happen to your small business if your partner died tomorrow? We all hope things like that never happen, of course. Still, it’s prudent to have contingency plans in place to deal with tragedy more easily.

Plan Ahead and Protect Yourself

The solution to planning for the untimely death of your partner is to purchase key person life insurance. This is life insurance on your partner that will pay out a benefit amount to your company in case of their death.

I’m from the insurance world, but I don’t sell this type of insurance. I do, however, buy it to protect myself. Small businesses rely on the few key people who operate it: the business owner, partners or employees.

Any business with fewer than 50 people is highly likely to have a high volume of important knowledge, relationships and production flowing through select people. If a key person gets hit by a bus one day, it will have a significant impact on the business and its ability to function. I know if my partner were to disappear from our company, we’d be without a leading force for our sales and a knowledge base that I couldn’t begin to recuperate.

The financial impact to our bottom line would be significant. That’s why we’re partners: I do what I do best, and he does his thing. We split the duties and responsibilities like any good partnership.

Don’t Learn Lessons the Hard Way

We saw the value of key person insurance a few years back when we purchased a small distributor of jewelry and gift shop items. The business was over 60 years old and run by the founder’s youngest son who was nearing retirement.

In the preceding decade, numerous family members who worked inside the business passed away. The youngest son had suffered through years of emotional stress, endless hours, and had barely kept the business afloat. He’d dumped his entire net worth in the business to keep it alive. If the family had purchased key person insurance, the financial struggles could’ve been mitigated or avoided entirely.

I’m sure most of you have little interest in becoming insurance experts. Now that the potential need for key person insurance has been illustrated, here’s how it works.

Figure Out What Plan Suits You Best

You purchase what is essentially a life insurance policy on your partner (or key employee). You can buy term insurance, which means the policy will have a definite term, say 20 years. There are terms of all lengths: five years, 10 years, and so on. You can always renew, extend or change to a different term or policy later. Get quotes from your insurance broker on policies with values of $100,000, $250,000, $500,000 and up.

Of course, the amount depends on how much money you think you’d need in a payout to help deal with the loss of the key person in question, and what you can afford (Byron Udell does a good job explaining how to choose a plan on NFIB). Pay the monthly premiums out of the company, and please note that they are not tax deductible.

Hopefully, it’s a relatively quick process that leaves you sleeping better at night. Small business owners have enough to worry about. With key person insurance, as Forrest Gump says when he hits it big on Apple stock and no longer has to worry about money, “That’s good. One less thing.”

Nathaniel Broughton is a partner at Plus2 Capital, a private fund that owns and PolicyZip.